Should you go for the proven blue-chip stocks of the FTSE 100, or look lower down the UK’s indexes to the smaller companies of the FTSE 250?
The potential difference, at least over the recent medium term, was brought home to me when I was talking to a friend who holds a FTSE 250 tracker. While the two indexes have not strayed too far from each other for the earlier part of their lifetimes, jostling for marginal first place, what’s happened so far in the 21st century is quite remarkable.
The two started to diverge in early 2003 and since January that year, the FTSE 100 has grown by 110%. But over the same period, the FTSE 250 has soared by 410%!
FTSE 100 dividends will have been slightly higher than FTSE 250’s, but even taking that into account, the index of mid-cap companies has comfortably smashed our collection of top blue-chip stocks.
But before we wonder which is better, I think we really should consider the relative valuations of the two indexes.
The total value of all the companies in the FTSE 100 comes to a little over £2trn, while the FTSE 250 adds up to around £400bn. So our biggest 100 companies in total are worth five times the next biggest 250. Think elephants and galloping.
There are other important differences too, which I think should have a significant bearing on our investment decisions.
Income vs growth
The FTSE 100 has a significantly higher proportion of mature dividend-paying stocks. For example, the biggest in the index (by some way) is Royal Dutch Shell, valued at more than £200bn (or about half the value of the entire FTSE 250). While considered by many as a byword for reliable long-term dividends, it’s hardly likely to offer the growth potential (or risk, mind) of smaller exploration-focused oil firms in the FTSE 250.
So if you want income, the FTSE 100 might be the one to go for, especially as it’s currently offering an average dividend yield of around 4.4% for the coming year, ahead of its long-term trend.
On the other hand, there are going to be more possible picks for the growth investor among the smaller companies of the FTSE 250, commensurate with more risk.
Global vs UK
The other major difference is that there’s a far wider global presence among FTSE 100 companies. Look at Shell again — it has enormous global reach and really isn’t at all affected by what happens on these small islands.
FTSE 250 companies, by contrast, tend to be a lot more UK-focused and far more susceptible to the UK economy and to its politics.
So choosing between the two indexes is one way of choosing between more globally focused investments and a more UK-focused strategy — who thought index tracker funds could be so flexible?
Which is better?
Have the two indexes switched into a new paradigm this century and will the FTSE 250 continue to outperform the FTSE 100? Well, a lot of that could depend on how the UK handles Brexit. And that’s looking very uncertain right now. One thing I would definitely not do is choose my preferred index for investment based on guesswork over where it’s going in the next few years.
Views expressed in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.